The path to net zero: why financial firms need to change the way they invest

Finan­cial firms hold the purse strings to the planet’s future. With­out the sup­port of the finance sec­tor, there is no road to net zero. Busi­ness­es in almost every sec­tor of the econ­o­my need fund­ing to adapt to clean­er, green­er ways of oper­at­ing and man­age the risks asso­ci­at­ed with a warm­ing world. Inno­va­tions that could help to keep car­bon emis­sions below 1.5C also require major invest­ment, along with new sus­tain­able ser­vices and prod­ucts for con­sumers.

As well as fund­ing the tran­si­tion to net zero, finan­cial firms need to shift invest­ment away from heavy pol­luters too. One recent report from the CDP revealed that financed emis­sions are a stag­ger­ing 700 times larg­er than finan­cial firms’ direct oper­a­tional emis­sions. As well as address­ing their own car­bon foot­print, finan­cial com­pa­nies need to mea­sure and dis­close the envi­ron­men­tal impact of their port­fo­lios, and ful­ly incor­po­rate envi­ron­men­tal costs into their invest­ment deci­sions.

Giv­en the imper­a­tive nature of cli­mate change, it’s per­haps not sur­pris­ing that one of COP26’s pri­ma­ry the­mat­ic streams focus­es on the green econ­o­my. Estab­lish­ing a tru­ly sus­tain­able glob­al econ­o­my is a huge chal­lenge, of course, but it should­n’t be seen as a bur­den. In fact, as Mark Car­ney, for­mer head of the Bank of Eng­land and now a UN Spe­cial Envoy for the US, has sug­gest­ed: “The tran­si­tion to net zero is cre­at­ing the great­est com­mer­cial oppor­tu­ni­ty of our age.”

There are tril­lions of dol­lars to be made from the right invest­ments in renew­able ener­gy, green hous­ing and alter­na­tive food sources. Thanks to strong returns, solar and wind ener­gy have already become sta­ple parts of invest­ment port­fo­lios, for instance. But when it comes to emerg­ing tech­nolo­gies, the sketchi­ly defined path­way to net zero com­pli­cates mat­ters.

Invest­ments in promis­ing areas like car­bon cap­ture and green hydro­gen might not deliv­er good returns for some time. And while low-car­bon retro­fitting is an essen­tial part of reach­ing net zero, it’s often chal­leng­ing to under­take.

That’s a par­tic­u­lar­ly acute prob­lem for big investors like pen­sion funds, which seek pre­dictable, con­sis­tent returns over a long peri­od. But reach­ing net zero is such a huge task that gov­ern­ment can­not fund every new tech­nol­o­gy or retro­fit on its own. “By neces­si­ty, it requires pri­vate sec­tor finance or some com­bi­na­tion of gov­ern­ment and pri­vate sec­tor finance,” says Jim Cole­man, head of eco­nom­ics at WSP.

Gov­ern­ments can help to mobilise pri­vate finance by shar­ing the ini­tial invest­ment risk in green infra­struc­ture and promis­ing new tech­nolo­gies, or by guar­an­tee­ing cer­tain returns. Such arrange­ments already exist for off-shore wind, for exam­ple. “But it might also have to exist for some of the new­er tech­nolo­gies or more nascent things,” says Cole­man. 

The UK’s Nation­al Infra­struc­ture Bank could poten­tial­ly play a role here. Along with a UK green tax­on­o­my to tack­le green­wash­ing and green sov­er­eign gilts, it’s one of sev­er­al mea­sures designed to help the UK reach net zero by 2050. Is Lon­don set to become a glob­al hub for green finance?

It cer­tain­ly looks that way to Louise Wil­son, co-founder of Abun­dance Invest­ment, which helps peo­ple to make eth­i­cal and social­ly ben­e­fi­cial invest­ments that con­tribute to a green econ­o­my. She says that if the UK does­n’t become a leader in sus­tain­able finance, it would be a major missed oppor­tu­ni­ty. “The City of Lon­don is keen to do it, the Trea­sury is keen to do it,” she says. “It makes sense as we’ve got so much to offer.”

Although the UK appears to be mov­ing in the right direc­tion on green finance, more finan­cial instru­ments that com­bine pub­lic and pri­vate invest­ment would undoubt­ed­ly be wel­come. That goes dou­ble for nations in the devel­op­ing world, where the shift to a more sus­tain­able econ­o­my has bare­ly got under­way. As such, Cole­man believes that financ­ing the shift to net zero must be a tru­ly glob­al effort.

He says: “Even if we were real­ly suc­cess­ful here in the UK, if no one else has man­aged to do it then it does­n’t real­ly mat­ter. We’re still going to suf­fer the neg­a­tive con­se­quences. So there has to be a lev­el play­ing field glob­al­ly for these kinds of fund­ing mech­a­nisms.”

More long-term think­ing and polit­i­cal con­sen­sus around reg­u­la­tion would also help to cre­ate a more pre­dictable invest­ment envi­ron­ment. “Even if it was rel­a­tive­ly tight reg­u­la­tion but you knew it was in place for a long time, then you could adjust to it and deal with it some­how,” says Cole­man.

How­ev­er, while big investors would undoubt­ed­ly wel­come more reg­u­la­to­ry cer­tain­ty, they still need to act now regard­less. “There are always uncer­tain­ties, so you need to live with that,” says Cole­man. “Don’t wait for this reg­u­la­to­ry cer­tain­ty to hap­pen.”

One reg­u­la­to­ry change that has already hap­pened is the EU’s new Sus­tain­able Finance Dis­clo­sure Reg­u­la­tion (SFDR), which requires fund hous­es, insur­ers and pen­sion funds that pro­vide finan­cial prod­ucts or ser­vices in the Euro­pean Union to dis­close their true sus­tain­abil­i­ty cre­den­tials. It aims to pre­vent finan­cial firms from cap­i­tal­is­ing on increased demand for sus­tain­able invest­ment by green­wash­ing their prod­ucts, and instead dri­ve invest­ment to firms that offer gen­uine alter­na­tives.

Abun­dance Invest­ment is one such firm. Wil­son, who left main­stream bank­ing after she became frus­trat­ed with its response to cli­mate change, says the bur­den of proof cur­rent­ly falls upon firms that are try­ing to do good: “Actu­al­ly, what we need to do is lev­el the play­ing field, and dis­clo­sure report­ing will do that.” 

Oth­er levers that could be deployed to speed the shift to a green econ­o­my include stricter emis­sions cri­te­ria for investees. Finan­cial firms could insist that com­pa­nies in their port­fo­lio work toward net zero goals, for exam­ple, and make it clear that if cer­tain tar­gets are not hit, sup­port may be with­drawn. But this all depends upon good ESG data from those seek­ing finance.

Although we’re still very much at the begin­ning of the path to net zero, there are signs that the finan­cial indus­try knows it needs to change. Indus­try groups like the Glas­gow Finan­cial Alliance for Net Zero (GFANZ) aim to encour­age firms to shift funds from high-car­bon invest­ments to low-car­bon infra­struc­ture and tech­nolo­gies, for exam­ple. But while lenders such as Stan­dard Char­tered, HSBC and Bar­clays have all made pub­lic com­mit­ments to reach net zero tar­gets by 2050, the fact that they have not yet stopped financ­ing fos­sil fuel com­pa­nies shows more action is still need­ed.

Activism from share­hold­ers and the wider pub­lic can help to keep the pres­sure on firms that are yet to ful­ly com­mit to the green econ­o­my. In fact, a sur­vey by PA Con­sult­ing of 3,500 con­sumers found that 93% expect sus­tain­able finance to be the norm in future.

“If you look at why the finance sec­tor is already chang­ing, it’s because peo­ple are increas­ing­ly demand­ing that it changes,” says Wil­son. “All the tril­lions of cap­i­tal that’s out there – at the end of the day that’s our mon­ey, not the fund man­agers’ or the chief exec­u­tive of the banks’. And peo­ple are now start­ing to say ‘I want some­thing dif­fer­ent. I want my mon­ey to act in a way that’s aligned with my val­ues and the things I want for future gen­er­a­tions.’”